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Learn to love the taper
The minutes from the October Federal Open Market Committee (FOMC) meeting were released on Wednesday. The FOMC meets every month to decide whether the Fed will change its monetary policy actions going forward, and investors pore over these minutes for any insight as to future policy direction. The latest minutes have a striking theme: the Fed wants out of the QE (quantitative easing) game—and sooner than later.
As with the speech by Ben Bernanke earlier this week, I get a sense that the Fed is trying to convince the market that forward guidance is the main event and QEternity is only a side show. That might be the case, but when reviewing U.S. stock performance over the last year, it’s difficult not to come away with the feeling that tapering asset purchases would be bearish.
Read my lips: Tapering isn’t tightening
Or at least that’s what the Fed wants the market to believe.
For that to really be true, though, a taper announcement would likely need to accompany another policy change viewed as more dovish. The FOMC reviewed a couple possible options, including cutting interest paid on excess reserves held at the Fed and lowering the unemployment rate threshold of 6.5%. Committee members were divided on these choices, though, so the likelihood of either seems limited.
In the short run, there are a few important macro considerations that could combine to affect the direction of the stock market going forward. The first is the timing and size of the taper. The Fed is getting anxious about its balance sheet size, so this is becoming more and more inevitable. Earlier than expected is probably bearish. The second macro consideration is the use of forward guidance of the future path of interest rates. If the taper is perceived as tightening, the market’s expected timetable for rate hikes will be pulled forward, which would probably be bearish. The third macro consideration is any additional policy changes that accompany the taper announcement. Most of the options here seem to be expansionary, so any bone the Fed throws the market would probably be bullish.
With all that being said, the distribution of outcomes for U.S. stocks seems biased upwards, as the Fed balked the last time volatility increased and the market has significant momentum going into year end.
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